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The hidden risk to the economy in corporate balance sheets

 
Published Aug. 24, 2016

NEW YORK — America has a debt problem, but it's not what you think.

Yes, the federal government owes trillions of dollars more than it did a few years ago. Yes, Americans are still struggling to pay off mortgages and student loans. But it's the buildup in debt elsewhere that is most worrying some experts, and the big borrower this time may come as a surprise: Corporate America.

Much of the cash is held by just a few companies, while debt is ballooning at other, weaker businesses as investors desperate for income rush to lend to them. These investors could face losses, perhaps steep, if economic growth falters.

"There's a misconception that companies are swimming in cash," says Andrew Chang, a director at S&P Global Ratings. "They're actually drowning in debt."

It turns out there's a wealth gap among companies, just like among people. Of the $1.8 trillion in cash that's sitting in U.S. corporate accounts, half of it belongs to just 25 of the 2,000 companies tracked by S&P Global Ratings. Outside of Apple, Google and the rest of the corporate 1 percent, cash has been falling over the past two years even as debt has been rising.

You don't have to look hard to find other signs of trouble.

The number of companies that have defaulted so far this year has already passed the total for all of last year, which itself had the most since the financial crisis. Even among companies considered high quality, or investment grade, credit rating agencies say a record number are so stretched financially that they're one bad quarter or so from being downgraded to "junk" status.

The problem with high debt is it leaves less wiggle room for even seemingly well-run companies if things go wrong.

In March, S&P cut its ratings on Macy's to BBB, two notches above junk, as competition from Internet retailers continues to dig into the department store chain's sales. The company's debt, net of cash, has risen over the past three years.

Oil company Hess was also recently downgraded, mostly because of a plunge in oil prices beyond its control. But its own moves hurt, too. Instead of whittling away at its debt with the cash it raised in recent years from selling parts of its business, it has spent billions buying its stock. Moody's Investors Service cited Hess' heavy debt burden when it downgraded the company.

Despite the warning signs, investors continue to lend to companies as if there is nothing to fear.

They put a net $22.8 billion into mutual funds specializing in corporate bonds in the 12 months through July, lifting total investments via such funds to $144 billion, according to Morningstar. The headlong rush reflects desperation for something a little more rewarding than the stingy interest paid by Treasury bonds and other traditionally safe bond offerings. The yield on the 10-year Treasury hit a record low last month.

Joseph LaVorgna, chief economist at Deutsche Bank, is worried about the risk posed beyond investment portfolios.

Few experts are so worried that they expect corporate debt to be the source of the next financial crisis. And not all the numbers on corporate debt are bad.

Defaults are jumping, but they're mostly confined to energy companies hit hard by a collapse in oil prices. Exclude those companies, and defaults are still ahead of last year's tally, though not at a post-crisis high.

And while debt is high, low interest rates have helped lighten the burden.

Companies in the Standard & Poor's 500 index are generating enough operating earnings to pay the annual interest due on all their debt six times over, according to Goldman Sachs. That so-called interest coverage ratio isn't great, but it's not terrible, either. It was higher — meaning healthier — a few years ago before companies went on a borrowing streak, but it's not far off its long-term average.

Of course, investors can get things horribly wrong. They didn't catch the last debt bubble, pouring money into bonds containing mortgages despite signs that homeowners couldn't afford them.